FIXED INCOME MODULE 47

Question 1

47.1 Name some features of fixed-income securities

Answer 1

maturity- they have an end date (given by an actual date or a number for years

coupon - interest, expressed as a percentage of par

seniority - debt is more senior to equity

contingency provisions - like a call or a put option, or ion it is convertible. it is an EMBEDDED OPTION

Question 2

47.1 In the CFA curriculum, we assume the principal is ____ unless told otherwise:

Answer 2

$1000

Question 3

47.1 the assumption in the FI curriculum is that coupons are paid …

Answer 3

semi annually

Question 4

47.1 What is a contingency provision?

Answer 4

an embedded option

whether that is a call or put option, convertible …

Question 5

47.1 How do we calculate current yield?

Answer 5

current yield = annual coupon / bond price

(current bond price)

Question 6

47.1 What are the main criticisms of the current yield calculation?

Answer 6

Timing = just uses annual coupon, does not consider that the coupon is paid more than once annually

Also does not consider what the bond is going to do by the end of its life

Question 7

47.1 What does the YTM calculate?

Answer 7

Calculates the return an investor is earning baed on the coupons, the principal amount, and the current price

Question 8

47.1 Describe each of these factors:

Answer 8

N = number of payments

PMT = actual physical cash that is going to be paid out in each coupon

PV = price today. NOTE: if you put your payment as a positive figure, you need to put your PV as a negative figure)

FV = principal value they will get back at end of the period

Question 9

47.1 Why can the current yield be different from the YTM?

Answer 9

current yield just looks at the annual coupon, YTM thinks about when coupons are paid

YTM considers the difference between current price and principal, whereas current yield assumes you get back the current price as principal in the end

Question 10

47.1 what would the yield curves of government issuers vs corporations look like?

Answer 10

because corporate bonds ar more risky

yield is higher the longer you invest

Question 11

47.1 What do we generally see in yield curves?

Answer 11

upward sloping - the longer the time, the higher YTM

Question 12

47.1 what is a bond indenture / trust deed?

Answer 12

This is the legal contract between the issuer and the bond investor.

Contract which sets out all the terms and conditions of the transaction.

Question 13

47.1 Who is the trustee?

Answer 13

The trust deed is held and managed by the trustee (typically a financial institution)

They insure that the issuer makes all the payments required - (and if they don’t, they takes action on behalf of the bondholders).

They are independent but act on behalf of the bond holders, representing their interests

Question 14

47.1 What does it mean for a bond to be secured/unsecured?

Answer 14

whether the bond has a claim over any asset over the issuer or not

Secured bond has a claim to a specific asset (which is pledged as collateral)
- gives them a higher seniority

unsecured - don’t have a claim over a specific asset, but you get to claim what is left of the assets

Question 15

47.1 What is the collateral/lien/pledge?

Answer 15

collateral - like house in a mortgage

Question 16

47.1 What are covenants?

Answer 16

affirmative / negative convents

affirmative covenants - things that the issuer must do
- must ensure they make their payments on time
- must ensure assets are used as collateral

negative covenants - things that restrict the issuers actions (amount of equity going to shareholders eg)

Question 17

47.1 What is an indenture?

Answer 17

An indenture is the contract between the company and its bondholders and contains the bond’s covenants.